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Amateur investors flirt with disaster by making risky bets

From Newsmax

Dreamstime/Alain Lacroix

After years of falling debt yields and new technologies enabling one-click purchases of complex financial products, mom and pop investors around the world are making bets that put them at danger of getting burned.

In South Korea, regulators are investigating sales of derivative-linked products that caused individuals to lose almost all their invested money. Chinese savers have ignored government warnings about possible losses on so-called wealth management products. In India, shadow banks whose woes have triggered a credit crisis have sold bonds to the public. The list goes on.

Amateur investors are trying to make up for decreasing yields by getting into risky markets they aren’t familiar with and don’t fully understand, and those bets are popping up all over the globe. Advances in technology including high-speed computing may also be fueling speculative trading, and in the worst case the fallout could be mass individual defaults that hurt the financial sector, according to Rawley Heimer at Boston College.

“New financial technologies have made it easy for retail investors to speculate in financial markets such as forex, structured products and cryptocurrencies,” said Heimer, an assistant professor of finance at the Carroll School of Management who studies individuals’ financial decisions. “Retail investors are often vulnerable to sudden price changes in these markets, especially when their trading activity is abetted by leverage.”

U.S. Investors

Individuals in the U.S. have also been getting into products that can be illiquid and unusual. In the $4.4 trillion U.S. exchange-traded fund industry, the spotlight is on leveraged products that use derivatives to boost their returns.

While they make up a small part of the country’s ETF market, assets in these juiced-up instruments grew almost 25% in 2019 to about $52 billion, data compiled by Bloomberg show. The Securities and Exchange Commission is considering requiring additional broker checks on investors that want to buy these vehicles to ensure they understand the risks involved.

That’s because failure can be disastrous, as investors in XIV — a leveraged exchange-traded note that bet against stock fluctuations — discovered in 2018. The VelocityShares Daily Inverse VIX Short-Term ETN was so popular with amateur traders it even had its own thread on discussion board Reddit, but that became a forum to swap war stories after the product lost 90% of its value and shuttered when volatility unexpectedly spiked.

There’s a case to be made for authorities reducing the amount of leverage that retail traders can take, to limit their losses, according to a paper by Heimer at Boston College and Alp Simsek at the Massachusetts Institute of Technology.

While U.S. individual traders have tended to lose money in the foreign exchange market due in part to overconfidence, the losses decreased significantly after authorities restricted the provision of leverage in 2010, according to the paper.

Another paper shows that when rates are declining, investors tend to make more dangerous bets even when risk premiums remain unchanged. That may be partly because they have established reference points on the investment returns they expect, and they make riskier bets when their expectations aren’t met, according to the paper by Chen Lian at MIT, Yueran Ma at the University of Chicago and Carmen Wang at Harvard University.

One product that Asian investors have been pouring into is fixed-maturity funds, which typically offer regular payouts but don’t guarantee returns even if some cite targets. Their asset managers may at times need to load up on riskier notes to try to meet the goals on returns and the maturity terms of the funds. Regulators in Taiwan tightened rules on the products last year after investors flooded into them.

The dangers of individual investors getting into risky debt can be seen in the grim outlook for people who bought securities of Singapore’s Hyflux Ltd. Around 34,000 retail investors in the once high-flying water treatment company now face the possibility of near-total losses.

Many investors appear to want a little extra yield even when markets turn volatile and they park their money in safer assets. BNP Paribas Asset Management, for instance, is offering portfolios whose allocations may be something like 95% bonds and 5% options strategies rather than 100% bonds, to improve the overall yield.

© Copyright 2020 Bloomberg News. All rights reserved.

For more on this story go to: https://www.newsmax.com/finance/streettalk/amateur-investors-risky-bets/2020/01/22/id/950880/?ns_mail_uid=6952f1f9-507d-4a20-8cc0-0a1db158d76e&ns_mail_job=DM85322_01232020&s=acs&dkt_nbr=01050260fqke

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